The following commentary comes from an independent investor or market observer as part of TheStreet's guest contributor program, which is separate from the company's news coverage.NEW YORK ( TheStreet) -- Today I'd like to review and expand upon my recent views on the stock market and the economy. 1. The economy is worsening because of the one-off Japanese disaster of March 11 that led to the largest supply-side shock since 1921. The recent Japan Machinery Order Report showed a worse-than-expected 3.3% drop in April, but those data are more than a month old. When you're dealing with a short-term disruption, one month might as well be an eternity. The Bank of Japan is forecasting a modest recovery as soon as June/July and a full recovery by November. Production in Japan is still constrained by power shortages, but many large-cap companies have announced plans to resume full capacity sooner than expected. Both President Obama and Federal Reserve Chairman Ben Bernanke have remarked that the current economic soft patch in the U.S. is largely influenced by Japan. Bernanke is forecasting a return to growth in the second half of 2011 even without plans for QE3. We agree with this assessment and are confident that investors will do what they do best and price in a Japanese recovery before it happens. The stock market is the most reliable forward-looking indicator that we have. Once Japanese stocks begin to climb, you can be confident that U.S. stocks will follow. Because of the declining rate of change of economic data, our E Weather portfolio is 65% in cash. From an economic perspective, when should the portfolio begin the re-invest that cash? Common sense would tell you to follow the action of Japanese leadership stocks, and that is exactly what we are going to do. We have created a basket, or mini-index, of Japanese leadership stocks that includes Toyota ( TM) (the world's top automaker), Kyocera ( KYO) (which makes electronics components), Kubota ( KUB) (Japanese machinery), Hitachi ( HIT) (consumer electronics), and the iShares MSCI Japan ( EWJ) and iShares:S&P/TOPIX 150 ( ITF) exchange-traded funds. At this stage of the economic cycle, the action in Japanese leadership stocks is of primary importance. We will be using this mini-index as a leading economic indicator. From March 11 through June 13, the Japanese leadership mini-index lost 8.13% while the the S&P 500 lost 1.8%. But last week, the mini-index shed only 0.7% while the S&P 500 was down 2.4%. This means the S&P 500 is lagging leading Japanese stocks. When Japanese stocks eventually turn positive, it will be time to boost our allocation of U.S. equities.
2. From an economic perspective, Japan is the short-term problem, but construction/financial services is the long-term problem. Sustainable employment gains will be difficult to hang on to as long as 25% of our economy is suffering alongside housing. We expect that President Obama will soon announce an economic plan that he can take with him on the 2012 campaign trail. We expect this plan to attempt stimulate the housing market. If such a plan does get introduced it should have a positive effect on the stock market. Again, we need to look at leadership stock action as a forward-looking indicator. The SPDR S&P Homebuilders ETF ( XHB) is down 12.5% since late April, while the Select Sector Financial SPDR ( XLF) is down 10.9% and the S&P 500 has fallen 7.4%. If the XHB or the XLF rally, we will know that a cyclical bull market is on the verge of erupting. At E Weather, we have always felt that the initial 9-month rally from the March 2009 lows was merely stage one of the market recovery. Stage two has had a difficult time getting started because of fears surrounding European debt contagion, turmoil in the Middle East and North Africa, and the current economic soft patch caused by Japan. If any semblance of confidence returns to the housing sector it could ignite a significant long-term rally. 3. Although housing remains weak, we must remember that most of the damage is already priced into the market. Housing only matters when a short-term shock to the system, like Japan, reveals the true fragility of our recovery. These short-term shocks do, however, work both ways. Last Thursday we learned that the weak dollar is doing its job as U.S. exports are picking up dramatically. The April report showed an 18.8% year-over-year increase in exports, which more than makes up for a weak housing market. Combine this with the 12% three-month surge in commercial and industrial lending, the 19.2% rise in May tax receipts (despite a cut in payroll taxes), and the 55% rise in individual income tax payments, and it lends credence to the thesis that U.S. equities could find reason for optimism in the midst of a June/July Japanese recovery.
Federal government revenues have increased 10.7% in the last year, while spending has increased by only 4.4% even without any tax increases. The 12-month rolling total of the federal budget deficit has declined from $1.36 trillion to $1.29 trillion over the past year. This is what usually happens in an improving business cycle. From this perspective, the brash statements being made in the media suggesting the U.S. is worse off than Greece are irresponsible and conceal a hidden agenda. There is a very real chance that both the economy and the stock market will reach lows in June and have plenty of ammunition to bounce. Forecasting the long-term destruction of the U.S. seems a little premature. 4. We remain convinced that Apple ( AAPL), Sina ( SINA), Netflix ( NFLX) and Baidu ( BIDU) will lead the recovery off the summer lows. Now is the time for the Economic Weather Station to do its job and signal to us the opportune time to reinvest our 65% allocation of cash. These next purchases are very important. Get the timing right, and you could find yourself with some wealth-building positions that more than make up for the market's recent selloff. At the time of publication, Schwarz held bullish positions in Apple, Sina and Netflix.